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What’s Behind the Government Bond Yield Spike?

It seems the “race to the bottom” days are a thing of the past for mortgage rates, as bond yields remain at yearly highs – hitting a 52-week peak of 1.92 per cent. It’s a contributing factor to the fixed mortgage rate increases we’ve seen from various lenders over the past few weeks – and the upward trend doesn’t look to be easing soon. This is leading to fears of a renewed financial crisis as the pressure of higher yields is felt in markets worldwide.

How Do Bond Yields Affect Fixed Mortgage Rates?

Government bond yields have a negative relationship with investor interest: when many investors are buying bonds, they push up the bond prices, and yields decrease as a result. The opposite occurs when investor interest is low, which in turn increases the cost of funding fixed mortgages for banks, who respond by increasing their mortgage rates.

Why Are Bond Yields So High?

While Canadian bonds and rates are affected, new economic developments in the U.S. are actually behind the increase of government bond yields on a global scale. The U.S. Fed has confirmed plans to reduce quantitative easing measures, with the goal of ending the program altogether in 2014.

Quantitative easing is a stimulus method in which the government buys up their own national securities in order to keep yields, and the cost of borrowing, low. This has been a main method used by the U.S. to jump start economic recovery, and injects $85 billion into their economy each month.

In its report, the bank stated, “… the time has not been well used, as continued low interest rates and unconventional policies have made it easy for the private sector to postpone deleveraging, easy for the government to finance deficits, and easy for the authorities to delay needed reforms in the real economy and in the financial system. After all, cheap money makes it easier to borrow than to save, easier to spend than to tax, easier to remain the same than to change.”

The Fed announcement that such measures were on their way out signalled to many investors that interest rates were in for a rise – and as a result, many interest-sensitive securities have taken a tumble on the markets, blindsiding investors with rapid losses.

What Will Be The Impact Of Higher Bond Yields?

U.S. bond yields have bypassed the 2 per cent mark, raising concern of steep losses should they continue their upward trajectory; according to BIS, a 300-basis-point increase would cost the U.S. treasury $1 trillion, and steep GDP losses in a number of other countries. However, BIS warns that a reversal from quantitative easing is unavoidable to balance the U.S. economy.

Bracing For High Interest Shock

Indicators that rates could increase are the result of a strengthening economy – but withdrawing stimulus too fast could plunge the U.S. (and as a result, Canada) back into recession if consumers can’t handle the shock. This has been the main concern of Canada’s department of Finance Minister Jim Flaherty, who has warned Canadians that their record high household debt levels made them vulnerable to economic change.

In Canada, the cost of borrowing has been kept low by the Bank of Canada’s monetary policy, which has held theOvernight Lending Rate at 1 per cent, and the Prime rate at 3 per cent since September 2010. This has kept the cost of Prime-based loans, such as variable mortgage rates, low in order to encourage consumer spending post-recession. Economists expect the Bank to maintain stimulus conditions until 2014, but consumers can be sure that higher rates are coming, and those with tight debt commitments might find themselves spread too thin.

What Can I Do To Avoid Paying Higher Interest On My Mortgage?

If you’re shopping for a mortgage, a fixed mortgage rate provides the opportunity to ride out such market fluctuations for the long term – and the best five-year rates in the country are still competitively low, under the 3 per cent threshold. Compared with the rates in the 5 per cent range as recent as five years ago, today’s rates provide buyers with a bargain.

As well, while five-year mortgage terms tend to be the most popular, locking into an even longer term (such as a 10-year), may be the right move for some risk-averse home buyers.

Those with variable debt are well advised to focus on debt reduction now to avoid an increase in interest payments later on; for example, making a lump sum payment on your mortgage, or switching to rapid payments can effectively whittle down your principal debt while interest rates are still low.